Are you a newcomer to the world of cryptocurrencies and eager to delve into the realm of stablecoins? The guide on understanding pegging in crypto provides a comprehensive overview of this topic.
In the realm of decentralized finance (DeFi), pegged cryptocurrencies are gaining popularity.
Before delving into the mechanics of pegging in the crypto space, it’s essential to explore the concept of traditional pegging in economics.
In economic terms, “pegging” involves tying the value of an asset or currency to another asset or currency.
This linkage, often referred to as a “fixed rate,” involves maintaining constant peg ratios to ensure stability in a country’s currency.
Several nations have historically utilized pegs to attract trade and foreign investment, recognizing the advantages of a stable currency for international commerce.
Now, you might be wondering, “What does peg mean in crypto?” Let’s take a closer look at the intricacies of pegging within the cryptocurrency landscape.
What Does Pegging Mean In Crypto?
Cryptocurrency pegging ties the value of a digital asset on a blockchain to an external asset like a bank currency.
Most stablecoins are pegged to the US dollar for stability in the volatile crypto market.
Despite the push for independence, pegging brings stability, protecting investors from rapid fluctuations, hence the term ‘stablecoins.’
Also read: What Is Spot Trading In Crypto?
Types of Stablecoins
There are mainly four types of stablecoins:
- Fiat-backed stablecoins
- Crypto-backed stablecoins
- Commodity-backed stablecoins
- Algorithmic stablecoins
Let’s discuss them in detail.
Fiat-backed Stablecoins
Fiat-backed stablecoins, like USDT and USDC, maintain a 1:1 collateralization ratio with a reserve of fiat currency, reducing pegged asset volatility.
While commonly pegged to the US dollar, they can also be tied to precious metals or commodities.
Crypto-backed Stablecoins
Crypto-backed stablecoins use over-collateralization of existing digital assets to ensure a stable market price.
To obtain them, users deposit tokens as collateral, locked in a smart contract, and can retrieve it later by repaying the stablecoins into the contract.
Commodity-Backed Stablecoins
These stablecoins are backed by assets such as gold and silver.
When these commodities increase in value, the owners of these stablecoins benefit from the increase.
Algorithmic Stablecoins
Algorithmic stablecoins, not tied to fiat, crypto, or commodities, maintain stability through algorithms and smart contracts.
The supply of tokens is managed by the algorithm, reducing circulation when prices fall and issuing more when prices rise.
Now, let’s delve into soft and hard pegging in crypto.
What Is Depegging?
Depegging occurs when a stablecoin deviates from its intended peg. If a USD-pegged stablecoin’s value drops below $1, it’s termed crypto-depegged.
Depegging raises concerns about a currency’s effectiveness, especially for algorithmic stablecoins like Terra UST, which may lose peg during a market crash.
Failing to maintain the 1:1 ratio between the pegged cryptocurrency and the underlying asset can result in depegging, prompting stablecoins to often overlook the disclosure of reserve information.
Examples of Stablecoins
- Tether (USDT): Tether is a stablecoin giant and is pegged to the US dollar. It is one of the first stablecoins, has achieved widespread usage, and is one of the most traded digital currencies in the crypto market.
- Digix (DGX): DGX is pegged to gold and one token of DGX is pegged to 1 gram of gold. DGX maintains only top-quality 100-gram Swiss-made gold bars in its reserves.
- TrueUSD (TUSD): It is an ERC-20-based token. It is the first asset that is built on top of the TrustToken Platform. Also, it provides real-time proof of funds.
Conclusion
Stablecoins have gained recognition for their comparatively lower volatility when contrasted with other cryptocurrencies.
Long-term crypto investors appreciate them for their capacity to consistently maintain a value aligned with their peg, contributing to their popularity.
Through this article, we aim to provide clarity on the concept of a peg in the realm of cryptocurrency.
FAQs:
What is peg in crypto?
Definition: Peg in crypto refers to tying a cryptocurrency’s value to fiat currency, precious metals (e.g., gold or silver), or commodities (e.g., crude oil).
The value of the pegged asset depends on the price movements of the underlying asset.
What does it mean to peg a price?
Meaning: Pegging a price involves linking a currency’s exchange rate to another country’s currency, typically enhancing stability in the currency.
How does a currency peg work?
Operation: In a currency peg, a national government fixes its currency’s exchange rate to another country’s currency or a basket of currencies. This stabilizes exchange rates and promotes international trade.